ALTERNATIVE FINANCING: LEASE OPTION? RENT W/OPTION TO BUY? RENT TO BUY? Chapter 1.

Excellent, Lenn. I have not been involved with a lease option although I have a client who is considering it and this was most helpful. I don't feel particularly comfortable advising someone on these things, yet. The big risk I think is the potential sales price shift in the future...up OR down. As a seller I would be rather concerned about this as well the the risk of the tenant not taking care of the property (which can happen with any tenant, of course). However I can also see it could be a win/win if done correctly.

Jeff 

Hi Lenn, A option to purchase here in California is a financial instrument and may also be sold. The valuable consideration for the purchase of the option is best when it is not a part of the lease consideration. The share of any rents that may be contributed to the Buyer may not exceed the ( usual )6% that the seller may contribute toward the buyers closing costs without lender approval in advance. This advance lender approval is most difficult to obtain as the Buyer's loan will not have gone through underwriting and there would be no guarantee by the lending source, right up the time of funding. Talk about a Catch 22.

In a declining market, the lease option is a bigger risk for the option holder, as the property may decline in value * though still subject to appraisal * if the offer is written correctly to protect the Buyers interest. In an escalating market, it is a greater risk for the seller in that if the market values should increase, they would be saddled with the agreed to in advance price.

A possibility would be to procure a separate option to purchase at a future date ( 1st right of refusal). Then create a lease that may have a rent below market feature and the tenant can save their own money for the down payment. The risk is that the option is still a financial instrument that may be sold or even given to another party not related to to the tenant.

Getting both parties to sit with legal council can prevent many misunderstandings and may generate a workable transaction that is beneficial to both parties. Good Lawyers can make this sort of transaction doable.

Hi Lenn,

Thanks for the info, as well as breaking down all aspects of the lease option.  I have seen a few successful lease options here, primarily sales by an investor.  Investors look at the transaction solely by the numbers.  Buyer/renter/tenant must have the ability to get their credit healed up and the discipline to do that.     Other problem is that lots of agents don't understand lease/option and don't want (can't afford) to wait to get paid.  We are also seeing Contingent sales coming back now that our market is not on fire as it was the past 4 years, but Contingent on Sale of Buyers house is a different issue. 

List and Sell (and know all the possible avenues as well as the pros and cons of them)

                                                                        Gary @ RentonHomeFinder

How much over market are optionors willing and able to pay and how much of an option payment is normally paid up front?  I have heard 1% of the future value to buy the option and an additional 20% over market rent.  Can all this extra money just stay with the seller and the credit back be made at closing, if there is one?  Or do some of these funds have to stay in escrow?

Lenn:  Interesting and thought-provoking post; however, lease options have all but been outlawed in Texas in the recent past.  You can still do them here, but my broker (Keller-Williams) has marked them Verboten for those of us associated with them.  We can only do leases with first right of refusal clauses in them.  This has been driven by the volume of litigation cases in Texas over the Lease Option concept.  When prices are named in advance of an actual closing, usually someone walks away mad from the sales transaction and feels they have been taken advantage of.  My team leader was the past Chairman of the Texas Association of REALTORS and a real legal beagle and she has recommended to me many times to steer clear of these sorts of deals for the aforementioned reasons.

I too would like to hear the answer to Roberts question? i have been placing ads in our local paper asking renters to stop renting and buy. What i get from this lately are people wanting to rent to own. I know little on the subject so thank you for this post. This why I love the Rain.

In this market it can be a real win for the person that wants to purchase and can't finance the transaction just yet!

Hey Lenn~ I have done several Lease Options back in the 1990s and none of them worked out.

Good post.  Our market is just starting to weaken here in the NYC Suburbs.  It will be interesting to look into alternative deals.

How do you structure commissions on these?

All the best!

 

 

 

 

Lenn-Rock on lady!  This is excellent and exactly what I was looking for. You should be writing books!  Thanks you and just in time for our Business Resource Meeting! :)

Just another couple of thoughts as I'm getting ready to set one of these up --

Prior to buyer's possession, I'd recommend a home inspection.  Buyer and seller will know exactly what condition the property is in; it will eliminate arguements later over "that door was/wasn't broken before"; and any items broken during the term of the lease will be evident.

Also, consider putting a home warranty on the property.  It will keep major unforeseen repair costs down; and the seller could have the buyer to pay the service call fee (~$50) they can just deduct it from the rent.

-- Lupe Teel, GRI Teel & Teel and Associates

AS both a property manager AND a salesman, I HIGHLY recommend writing BOTH a lease agreement AND the Sales contract. Link them both together so that if you have to evict the tenant that cancels the sales contract, and so that if the Buyers don't buy you can cancel the lease (unless you WANT to just keep them as tenants).

Great Information. I  do a Get Mortgage Ready Program for my realtors that want to put together lease to purcahse programs.  This makes the buyer serious and we have an established plan for when they will qualify for the program.

John Thomas - Certified Mortgage Planner

Great post.  Very informative!!!

Excellent post everyone!  Lots of great information to use here!  Thanks again!

Lenn - excellent post. Thanks for starting this off, as I've already learned quite a bit about a transaction we handle quite often.

Recent law changes in Texas have certainly made the lease option more difficult (as Steve mentioned earlier), but with our attorney's guidance we still work them. We first sign a standard lease, followed by a purchase contract with a closing date 1-2 years forward. Since my firm includes mortgage brokerage services, we work with the buyer to correct any financing issues along the way (the program also includes a paid-for credit counseling service). Having a mortgage broker involved from the start also helps to make sure there is a legitimate chance the buyer can qualify in time.

We actually market for these buyers first, rather than just marketing our listings as 'lease option available'. We'll take an almost home buyer, find them a home, then arrange for an investment client to purchase the home. This works best with new homes that have 10-20% of negotiating room, allowing the investor to make a decent profit in addition to the monthly cash-flow. It also allows us to make a commission from the initial sale, thus we don't have to wait 1-2 years for a return.

Since Houston is such a stable market, assigning a purchase price up front is not such an issue. We typically base the price on a base value + a set appreciation.

My questions:

- Does anyone charge the home owner a fee for arranging the lease option? Rather than wait 1-2 years for a commission, why not charge a fee to the owner that is some percentage of the option fee? We have not tried this yet, but as most of our clients in these transactions are investors, it makes sense.

- Since we structure the transaction with two separate instruments -- a lease contract and an option contract -- the seller could have problems if the lease was broken. They now have an option contract for up to 2 years and no tenant. We add a clause to the option agreement that the seller may lease the home during the term of the option...as our clients are mostly investors, they're fine with this arrangement. But what if the home owner is really trying to move the property? it has not come up yet, but I remain concerned about this. Any suggestions?

Again, thanks for the post.

-Johnny